Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Modified: 04-Jul-20

“Selecting Top Stocks to Buy” is a series of articles written by us in which we have touched upon various steps required to be taken before an investor decides about investing in stock of any company. These articles deal with almost all aspects of stock selection ranging from attributes of a good stock investor to detailed analysis of companies.

These articles, if read in sequence and implemented with diligence, would help any reader whether he is well verse with finance or not, develop a sound process of stock selection.

However, each article is complete in itself. If a reader feels like going through a particular article out of turn, it would be perfectly fine, as it would help her get insights about the particular theme/step covered in that article.

If you are new to stock markets and wish to learn stock investing holistically, then I would recommend that you cover each article one by one in the sequence they are written.

 

Selecting Top Stocks to Buy – A Step by Step Process

 

Getting The Right Perspective Towards Investing

Choosing The Stock Picking Approach Suitable to You

Shortlisting Companies For Detailed Analysis

Understanding The Annual Report Of A Company

Finding out whether a Company is Cooking its Books/Manipulating its Numbers

Credit Rating Reports: A Complete Guide for Stock Investors

Detailed Analysis Of A Company: A Framework

Financial Analysis Of A Company 

Finding Self Sustainable Growth Rate (SSGR): a measure of Inherent Growth Potential of a Company

How To Analyse Operating Performance of Companies

Valuation Analysis Of A Company

Business & Industry Analysis Of A Company

3 Simple Steps to Assess “Margin of Safety” of a Stock

Management Assessment of Companies:

Final Checklist For Buying Stocks

How Many Stocks You Should Own in Your Portfolio

How to Monitor Stocks in Your Portfolio

Trading Diary of a Value Investor

3 Guidelines for Selecting Stocks Ideal for Retail Equity Investors

When to Sell a Stock

 

Most of these articles have been compiled in the form of an e-book (pdf format). You may read more about the e-book and its feedback from the readers in the following article: “Peaceful Investing – A Simple Guide to Hassle-free Stock Investing

Smaller Peaceful Investing Ebook

The learning of these articles has also been compiled in the form of a video series (a premium service). You may know more about it and watch the sample video in the following link:

Learn Investing by Online Videos

Fundamental Analysis, Value Investing, Bottom Up Investing Workshop, Peaceful Investing, Video on Demand, Portfolio Management, Screener Demonstration

 

I wish you all the best in your investing journey!

– Dr Vijay Malik

 

Answers of queries asked by readers about “Peaceful Investing” approach

 

Dear Sir,

I have been going through the various articles posted on your blog over the past year and have been asking queries from you as well. Thanks for your time and patient hearing always.

Your approach to investing is really “Peaceful” powered by strong filters you have on management, financial, business, and most importantly valuations. I have numerous queries associated with various articles on your blog, which I wanted to discuss. Some of them may be repetitions; however, I request you to provide detailed answers as always.

1) Criteria for shortlisting companies for detailed analysis:

Do you strictly follow the methods you have specified in the previously mentioned article i.e. companies exhibiting the following characteristics:

  • Sales growth 10Years >15% AND
  • Debt to equity <1 AND
  • Price to Earning <12 AND
  • Cash from operations last year >0 AND
  • Market Capitalization > ₹25 cr.

Your approach is to find companies with demonstrated history (7-10 years) of good financial and business performance with impeccable management quality trading at a PE ratio of less than 10. Your basic premise here is that the historic good performance of such companies is expected to continue in the future as well.

How do you arrive at the expected performance part of the analysis, as I understand you do not do any future forecasts / DCF valuation etc.? Mayur Uniquoters Ltd and Ambika Cotton Mills Ltd have definitely been good picks based on your peaceful methodology. However, the revenue growth has slowed down in the past 3 years although the 10-year CAGR is still good.

Advised reading: Shortlisting Companies for Detailed Analysis

 

2) Are we able to find investment opportunities in the current market scenario?

This approach has definitely helped you build a rock-solid portfolio. However, if I am not mistaken, you had spotted these companies during 2011-2014 when the valuation comfort was definitely there. For a relatively younger investor who wants to start investing now, valuation comfort does not appear to be there. In fact, the valuations specifically in the mid/small cap space have started soaring 2014 onwards (a market-wide re-rating a.k.a. Modi rally).

Essentially, what I am trying to say is that you need to sow the seeds during the bear market and for that the wait might be longer. I do not know if you are able to find investible stories in today’s market where the approach is fully consistent with your peaceful methodology, especially the valuations part of your detailed investing approach.

 

3) Investing in companies at turnarounds/inflection points:

I also understand from your various articles that you do not pay too much heed to short-term performance (good/ bad) while finding investible stories. Therefore, the popular theme of finding stocks whose businesses are at the so-called “inflection point” or has just posted the first good quarter/ financial year after a long history of poor performance such as Avanti Feeds Ltd posting significantly high revenues and net profit in FY12, does not work for you as you look for 7-10 years of good performance.

Similarly, there could be situations where the current earnings are close to NIL or negative and therefore PE ratio would be very high or rather infinity and fund managers justify buying saying that the company is on the verge of major change in its business profile and the high PE ratio would be normalized once earnings kick in.

I would tend to think that you would not like such stories. Is my understanding correct?

 

4) Paying very high PE ratio for stocks, which are expected to grow at high rates:

Even the popular theory of justifying the valuation of stocks with 20-30-50 PE ratio by saying that if a 20 PE ratio stock is expected to grow its earnings by 100% in one year, the effective PE ratio that an investor is paying is 10. This does not work with you as far as I have observed you. Many fund managers justify buying stocks with high PE ratio by giving this argument.

 

5) Investing in stocks where we do not see the margin of safety:

Have you bought any stock where you do not see the margin of safety i.e. earnings yield less than 10-year G-sec yield? The current G-Sec Yield is 7.8%, which translates into a maximum PE ratio of 12.8.

I know you recommend paying a bit premium for stocks, which come under your circle of competence and where SSGR is good. However, there also, you have strict limits.

Advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock

 

6) Using alternate valuation parameters:

Do you try to justify the valuation by looking at other parameters such as Price to Book Value, Price to Sales, EV/EBITDA, and Industry PE ratio when you are not comfortable with the high PE ratio of a company? Have you taken any buy decision based on that?

 

7) Are we currently buying stocks, which are in our valuation range including existing stocks in our portfolio?

While I understand “Follow My Portfolio” is a premium service, could you please let us know the number of companies that you have in your portfolio today excluding Newgen Software Technologies Limited?

Are you currently buying stocks, which are in your desired valuation band (including existing portfolio stocks)?

 

8) Documentation of stock analysis decisions

Do you document all the analysis that you do i.e. stocks that you have rejected and documented why you have rejected them? Similarly, do you document notes for exited and bought stocks?

 

9) Negative list of sectors:

Do you have any negative list of sectors where you will not waste your time in analysing the stocks? I know you do not like cyclical businesses where revenues and profitability fluctuate a lot even though 10-year CAGR of both revenues and profitability are decent.

 

10) Process for finding new ideas:

What is your workflow for finding new ideas? Screener alone or any other source as well. Do you read all BSE announcements on a daily basis to find new ideas? Alternatively, are you happy with one idea a year aided by online screeners followed by rigorous analysis?

 

11) SSGR vs (RoE x Earnings Retention rate):

I know you do not focus on return on equity (RoE) and return on capital employed (RoCE) and instead focus on SSGR.

Can one use RoE x Earnings Retention rate (where equity is the beginning value of the equity and not the average) as a proxy to SSGR (the way you have shown on your blog)? Are both these ratios the same?

Advised reading: Finding Self Sustainable Growth Rate (SSGR): a measure of Inherent Growth Potential of a Company

 

12) Tools for stock research and contacting management of companies:

Tools for research: Annual Reports, Quarterly Results, Earnings conference call (Concall) Transcripts, Credit Rating Reports, and Industry Reports. What else?

Do you prefer one to one conversation with the management or rely solely on what is available in the public domain?

In case of any doubt, do the company secretaries of the stocks under your research universe respond with satisfactory answers?

Advised reading: How should investors contact Companies/Management for clarifications or additional information?

 

13) Newspapers and magazines:

Any newspaper, trade journal, or magazines that you think have helped you.

 

14) Time taken to complete an analysis:

How much time do you take in general to complete your analysis?

I understand that you like to read the annual reports up to 10 years ago and go through the recent concall transcripts. For Bodal Chemicals Ltd, I noted that you went back to as old as for December 2012 quarterly conference call (concall) transcript. Do you read all quarterly transcripts? On the other hand, was this more for investigating dip in operating profit margin (OPM) during FY12?

I know quantifying time for analysis is quite subjective and depends on one’s intellect and availability of resources. Still, I would like to know how many days/hours on an average you spend after shortlisting a stock for detailed analysis?

 

15) Fear of missing the opportunity while the analysis of the stock is taking its time:

During the long analysis phase, do you worry about the valuations and likely miss of opportunity particularly in a rising market?

 

16) Amount of analysis needed before putting additional money into existing stocks in the portfolio:

You recommend that one should first buy the stocks currently in the portfolio if they come in the desired valuation band. Do you re-do 7/10 year analysis while buying again?

Why I am asking this is the stock could also be trading in the desired valuation range because the market participants believe that the growth has peaked.

Advised reading: How to Decide about existing portfolio stocks: Buy more/Hold/Sell

 

17) Importance of market value created per INR of retained earnings in the stock analysis:

What are your views on the market value created per INR of retained earnings by the company? Here we are factoring in the increase in market cap for every rupee retained. Increase in market cap is a function of the market price of the stock. While we are trying to find good stocks, which are not yet recognized by the market, why are we looking for the increase in market cap? This ratio could well be less than one as the market may not have recognized the stock yet and that should be the desired case. Isn’t it?

Thanks & Regards,

 

Author’s Response:

Hi,

Thanks for writing to us! We appreciate the efforts put in by you in reading most of the article of our website and in the attempts to assimilate our investing approach.

Let us attempt to answer your queries one by one:

 

1) Criteria for shortlisting companies for detailed analysis:

The shortlisting criteria/filtering criteria are used as a tool to narrow down the list of stocks for analysis. We keep on tweaking the parameters depending upon the results provided by the screening tool.

Moreover, we do not prefer to keep a strict valuation parameter in screening filters. This is because in case an investor puts a valuation parameter as filtering criteria, then there might be some good stocks just above her comfortable buying range, which she will never get to know about.

Advised reading: Shortlisting Companies for Detailed Analysis

We do not do future projections. If we are able to convince ourselves that the good past performance is because of efficiency and competence of the management and not merely due to luck/tailwinds, then we rely on the promoter/management to keep doing the good work that she has done in the past. Having financial data & annual reports of the last 7-10 years provides us with a business performance history to make this judgment.

 

2) Are we able to find investment opportunities in the current market scenario?

7) Are we currently buying stocks, which are in our valuation range including existing stocks in our portfolio?

Until now, we have not faced a situation where we have surplus funds and we are not able to find a stock to invest in. As mentioned in various articles on our website and well identified by you, we prefer first look at opportunities in the existing stocks in our portfolio.

We have been investing regularly ever since we started building our current portfolio in 2011, including in today’s times.

As rightly mentioned by you, the “Follow My Portfolio” service is a premium service. Therefore, the details of our portfolio including the number of stocks are available only to the premium subscribers and we would not be able to disclose this information.

 

3) Investing in companies at turnarounds/inflection points:

In our investing journey, we have found that if any stock in our existing portfolio undergoes a bad business period, then we are able to take an informed decision about its future.

Increasing our position in those stocks in our existing portfolio, which are facing headwinds has been a very good investment strategy for us. We could increase our position with confidence in such stocks in our portfolio because we had analysed them in-depth before the first purchase and in addition, we had further improved our understanding of their business by learning more about them as a part of monitoring exercises.

Until now, we do not find similar confidence in our decision making when we find any stock, which is going through a bad patch but is not a part of our existing portfolio.

One reason may be that it takes us quite some time to analyse and then build confidence in our decisions about any stock. Therefore, until now, we have not invested in stocks facing headwinds.

However, we all mature as investors with time & experience. Moreover, if in future, we believe that we have gained enough competence to decide with confidence about the future course of any company, which is currently facing challenging times, then we may start to look at the segment of turnarounds. However, as of now, we avoid investing in stocks outside our portfolio, which are facing rough patches.

Advised reading: How to do Business Analysis of a Company?

 

4) Paying very high PE ratio for stocks, which are expected to grow at high rates:

5) Investing in stocks where we do not see the margin of safety:

We do not believe in paying high PE ratio for stocks, which are witnessing very high growth rates. We do not invest in stocks that do not meet our margin of safety criteria. You may read more about the price that we are comfortable to pay for any stock in the following article:

3 Principles to Decide the Ideal P/E Ratio to pay for a stock

 

6) Using alternate valuation parameters:

We do not use parameters like Price to Book, Price to Sales, EV/EBITDA, and Industry PE ratio in our investing approach.

 

8) Documentation of stock analysis decisions:

We do not document the stocks that we rejected or sold. Moreover, as we have a concentrated portfolio where only a handful of stocks have been added or sold over past many years, therefore, it is not difficult to remember our reasons for purchasing or selling any stock.

 

9) Negative list of sectors

We do not differentiate stocks based on sectors and therefore, we do not have any negative list. Different stocks in the industries behave differently. We have noticed outliers in supposedly cyclical industries displaying stable profitability margins.

This is one of the reasons that we prefer bottom-up approach to investing and not the top-down approach.

 

10) Process for finding new ideas:

We use the screener to find investment ideas. We do not read BSE announcements on daily basis for all the stocks. We follow announcements for stocks, which are in our portfolio as part of our monitoring exercise.

 

11) SSGR vs (RoE x Earnings Retention rate):

SSGR and (RoE x Earnings Retention rate) are not the same. You may read the following article in which we have answered a similar query:

Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

 

12) Tools for stock research and contacting management of companies:

Annual Reports, Quarterly Results, Earnings Concall Transcripts, Credit Rating Reports are usually sufficient resources. Additional resources should be referred to get answers to any queries, which are not resolved by reading these documents.

We have experienced that company secretaries provide satisfactory answers. However, it may need a follow up on her queries by the investor.

 

13) Newspapers and magazines:

We prefer reading Mint, ET, Forbes, Fortune etc. However, they are not indispensable.

 

14) Time taken to complete an analysis:

We usually take a negative decision about any stock within a few seconds/minutes. Our stock analysis excel template, which presents the financial data of any stock from Screener in our preferred format like dashboard helps us in taking quick decisions especially about finding strength and issues in the company’s financials.

Whenever a stock shows promise initially and we start analysing it in detail, then the time spent in the analysis varies. It might be that after analysing it for a week we may come across some factor, which makes us decide against investing in the stock. Otherwise, usually a week to a month’s worth of analysis time may be needed for any stock to get an entry in our portfolio.

While analysing stocks for inputs to readers in the form of an article on our website, it usually takes about 7-10 days to analyse the stock and write the article.

 

15) Fear of missing the opportunity while the analysis of the stock is taking its time:

We do not think about valuations/opportunity cost during the analysis phase in a rising market.

 

16) Amount of analysis needed before putting additional money into existing stocks in the portfolio:

Incremental buying decisions are based on our conviction and views about the stock based on updated information as it arrives in the form of regular results/events. This information is added to the insight/knowledge that we have about the stock from our previous analysis.

It does not take us weeks or months in the analysis before taking the decision to put additional money in existing stocks in the portfolio.

 

17) Importance of market value created per INR of retained earnings in the stock analysis:

You are right that for a stock, which is unrecognized by the market, the market value created may be less than retained earnings. Therefore, if we find that a stock meets all our parameters, then we may remain indifferent to the market value created until now.

Hope it answers your queries. Once again, we appreciate the time & the effort taken by you to go through all the articles of the website.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

P.S.

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"Peaceful Investing": My Stock Investing Approach

“Peaceful Investing” approach is the result of my more than a decade of experience in equity markets. This approach helped me invest even when I had a full-time corporate job and therefore, could not spare a lot of time for stock analysis.

During my investing journey, I have faced almost all the common challenges of the investors; the biggest one being “scarcity of time”. “Peaceful Investing” approach keeps in mind that an investor will have only limited time for stock analysis. 

The objective of “Peaceful Investing” approach is the selection of such stocks, where once an investor has put in her money, then she may sleep peacefully. Therefore, if later on, the stock prices increase, then the investor is happy as she is now wealthier. On the contrary, if the stock prices decline, even then the investor is happy as she can now buy more quantity of the selected fundamentally good stocks.

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